30 Jan 2023
4 min read

How to implement KPI monitoring to support financial planning

Finance controllers discussing How to implement KPI monitoring to support financial planning
Quick summary

When you ask business leaders what's the most important thing in business? You get a variety of answers. Some say it's people; some say it's leaders. Others say operations, the product, or the brand.

However, if there's one thing that makes or breaks any of the above answers, it's financial management. Smooth operations, product innovations, leadership hires, and retention must all be backed by thoughtful, transparent financial management.

Table of Contents

    What are key performance indicators (KPIs) in Financial planning, and why do they matter?

    The financial plan of your business should apply current data and future forecasts to your overall business plan to ensure it's robust and realistic. The Key Performance Indicators are what you'll use to test your financial plan and are measurements of the performance of the business. They have these characteristics:

    • Key - they are crucial and indispensable. Choosing them means ignoring many other performance indicators you could consider but don't
    • Related to performance - they act as proxies for the business's health. You'll understand how well the organisation performs by understanding what they tell us
    • Measurable. If you can't measure it, it's not a KPI

    These KPIs help assist financial planning by providing crucial organisational feedback to support decision-making. The business needs to have a clear idea of what to focus on: is it profit margin? Lack of revenue? Working capital? KPIs isolate the problem so the business can tackle these issues head-on.

    In addition to this, you can use your KPIs as clear targets. If you understand where you are and what's possible, you can then formulate targets that focus your teams on achieving a certain level of performance.

    The ultimate guide to ERP x expense management integrations

    The eight KPIs every business should monitor

    The essence of a key performance indicator is that it is just that — key. This means that there should be just a few, and we should pay a lot of attention to each of them.

    The trick is to choose well. According to PWC, between four and ten KPIs are a good amount to monitor for most companies. The chosen KPIs should give most businesses a great understanding of their financial situation and allow for informed planning.

    Gross Profit Margin
    = (Revenue - Cost of Sales) / revenue * 100
    Gross profit margin is a measure of profitability without accounting for overheads. This KPI is most useful for products or portfolios, allowing comparisons without having to estimate their requirement for overheads.

    Net Profit Margin
    = Net Profit / Revenue * 100
    Net profit margin measures profit but considers all the business's fixed costs.

    Working Capital
    = Current Assets - Current Debt
    Working Capital is all the available liquidity you can use for day-to-day operations such as payroll, debt repayment, and account payables.

    Current Ratio
    = Current Assets / Current Liabilities
    The current ratio measures liquidity to ascertain that the business can pay any obligations within the year.

    Leverage
    = Total Assets / Total Equity
    Financial leverage measures risk to the business by calculating how much of the business assets are financed by debt. The bigger the number, the riskier the business.

    Debt to Equity Ratio
    = Total Debt / Total Equity
    The debt-to-equity ratio also measures risk in the business by seeing the ability of equity to cover all debt should a business downturn happen.

    Return on Equity (ROE)
    = Net Profit / (Beginning Equity + Ending Equity) / 2
    ROE indicates how well the business can use investments of its assets to generate a profit.

    Operating Cash Flow
    Operating cash flow measures how much cash a business is generating. Positive cash flow can grow operations, whereas negative cash flow requires additional financing to keep the lights on.

    See here for a more exhaustive list of Finance KPIs.

    Implementing a system for tracking and reporting on KPIs

    Follow this list to implement financial reporting in your business.

    1. Define and agree on the KPIs you will be tracking**

    First, consider what KPIs you want to track rather than starting with what is possible. Otherwise, we risk ending up in "KPI soup" and tracking and reporting on a wild number of KPIs, leading to confusion, lack of insight, and inaction.

    To pick what KPIs to track, you need to consider each KPIs' role in decision-making. Profit measures are useful because they point to imbalances between expenses and income.

    For example, a very low net profit margin should raise questions about the current costs of overheads and whether it's possible to reduce them for a healthy margin.

    On the other hand, debt-to-equity ratios might be something you can calculate once a year. Pay little attention if, for example, the business doesn't significantly rely on debt to finance its operations.

    In defining the KPIs to track, monitor, and report on, you must involve all stakeholders to ensure everyone is happy with their insight into the business performance.

    1. Agree on the frequency of reporting

    Once you understand the ideal scope of tracking and reporting, consider the frequency on which the finance function reports to the business.

    The reporting, of course, may happen at various levels and at various intervals.

    The CEO might be interested in monthly (or even more frequent!) reporting of various KPIs. However, board members will not need constant reporting.

    Companies that are transparent about the business's health have happy employees who feel they understand their contribution to the bigger picture. It's increasingly standard for finance teams to communicate with the wider business on key performance indicators, especially profitability measures.

    Consider quarterly, town hall-style meetings to communicate with everyone in the organisation, whether it's great, good, or not-so-good news.

    1. Pick a system for tracking KPIs

    Depending on the nature and maturity of your business, you might be able to track and monitor KPIs with Spreadsheets and Business Intelligence tools such as Microsoft BI and Google Data Studio or in combination with your accounting software.

    Accounting software will automate some of your tasks, such as payroll and tracking invoices and income, so that calculating profit, liquidity, and solvency is easy.

    However, most finance KPIs are based on calculated metrics, which means you will need to draw from various sources, like your expense management software, to obtain them.

    For bigger companies, Enterprise Resource Management (ERP) can be the ideal solution as it combines orders, inventory, manufacturing, and resource planning with the finance management function. Working with expense management software that directly integrates with an ERP is ideal. Having seamlessly connected data from payment to bank reconciliation can give businesses a holistic view of business health.

    1. Master the art of data visualisation

    You're only tracking KPIs because you have an audience that needs to know, and finance teams love numbers and graphs. However, a little effort in data visualisation can go a long way for people who are not day in and day out in front of data dashboards.

    De-cluttering graphs and editing so that key insights are highlighted will make everyone more likely to pay attention to the reports.

    1. Interpreting results

    Numbers tell a story, but only if you're listening and you speak the language. To interpret results, you need to be able to compare them.

    You have three options:

    • Compare them to your targets
    • Compare them to previous performance
    • Compare them to competitors

    If targets have been set, you should look at this because targets have been drawn up considering the market and competitors. If targets are missing, comparing previous periods can give a sense of how well management has led the business through all its functions.

    Finally, comparing to competitors, where data is available, can also be really insightful in understanding how different strategies are panning out in the competitive landscape.

    1. Zoom in on the real-time picture in with Payhawk

    Finally, a KPI system is only complete with accurate and real-time insight into your expense management. With Payhawk, you can stay in control of your outgoings with our all-in-one spend management software. Book a demo to find out more.

    Trish Toovey - Content Director at Payhawk - The financial system of tomorrow
    Trish Toovey
    Senior Content Manager
    LinkedIn

    Trish Toovey works across the UK and US markets to craft content at Payhawk. Covering anything from ad copy to video scripting, Trish leans on a super varied background in copy and content creation for the finance, fashion, and travel industries.

    See all articles by Trish →
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